About the turn of the 20th century communication systems and travel made it difficult for creditors to thoroughly check debtor’s credit history. Traveling distances between the sales office and debtor made it difficult to visit each customer to check up on them on any regular basis. What seems like a small distance today of 50 miles was a 2 day trip 100 years ago. So visits from creditor were far and few between.
To a dishonest debtor this was an opportunity. During the 1890’s depression creditors were faced with ramped scams whereby debtors would purchase large amounts of inventory, sell this inventory and abscond with the funds, never paying the creditors. The debtor would skip town, open a business under another name, and pull the same scam over and over again.
Of course, creditors had common law remedies against debtors, but even if judgments were obtained, collecting on the judgment proved to be difficult at best since the debtors often spent or hid the money.
This scam was at the height of American capitalism where caveat emptor was the prevailing law of the land. So in the early 1900’s the National Association of Credit Men lobbied to enactment federal bankruptcy laws and bulk sales laws throughout the United States. By 1909 all states had enacted bulk sales laws. However, these laws were not uniform. To a large degree, uniformity was achieved with the promulgation of Article 6 of the UCC.
Bulk sale laws are designed to protect creditors. However, they also give protection to transferees (buyers). The buyer/transferee is required to give notice to the creditors of the impending sales. Article 6 (1987 Official Text) of the UCC ("Original Article 6") places a burden on the buyer in bulk from certain specified businesses to notify the seller’s creditors before the purchaser receives delivery of the goods or pays for them. In the event the purchaser fails to comply with Original Article 6, the bulk sale transaction may be voidable by the seller’s creditors. A net effect of failure to comply is the buyer may have to pay more than once for the goods purchased in bulk.
(b) REPEAL OF BULK SALES LAWS
Over the past 100 years technology has made it easier for creditors to identify credit risks. Traveling to debtors is now a matter of hours, not days while credit agency reports are a key stroke away from pouring out reams of credit history on debtors. As a result, a number of states have completely abolished bulk sale laws. In the event of a bulk sale in these states, trade creditors will have no recourse against the buyer or the transferred inventory except in the case of fraud.
The repeal shifts the burden on the creditors for protection. It also paves the way for smoother and fast business sales without all the delay and expense of bulk sales transaction costs. In addition, statutes and laws have greatly improved the possibility of commencing a legal proceeding against a merchant who flees to another state. To the extent a bulk sale is fraudulent and the buyer is a party to the fraud, creditors have remedies under the Uniform Fraudulent Transfer Act (or the Uniform Fraudulent Conveyance Act) which has been adopted in many states.
Thirty-five states and Puerto Rico have repealed Article 6 in its entirety while 5 others have drastically modified and weakened the creditor’s position in bulk sale transactions. In the state completely repealing UCC Section 6, creditors shipping inventory to vendors in those states will receive no notice of a bulk sale.
California operates under a modified Division 6 of the UCC. In California, a "bulk sale" takes place if there is a sale of "more than half the seller's inventory and equipment outside the ordinary course of business and under conditions in which the "buyer has notice...that the seller will not continue to operate the same or a similar kind of business after the sale." When the principal business is the sale of merchandise the buyer must give public notice to the seller’s creditors by:
(d) RULES OF BULK SALE LAWS
(1) recording a notice in the County Recorder’s office in the county where the business is situated at least 12 business days before the bulk sale is to be consummated, or the sale, if by auction, is to commence;
(2) Publish the recording at lease once in a newspaper of general circulation in the judicial district where the business is located and where the chief executive office of the seller, or, if the chief executive office is not in California, the principal business office in California is located, if in either case there is one, and if there is none, then in a newspaper of general circulation in the county embracing such judicial district. Notice must be published at least 12 business days before the bulk sale is to be consummated.
(3) sending a copy of the notice by registered of certified mail at least 12 business days before the bulk sale is to be consummated to the tax collector in the county or counties in which the property to be transferred is located.
The notice to creditor shall state:
(1) A bulk sale will be made;
(2) The name and business address of sell and except in the case of a sale at auction, the buyer, and all other business names and addresses used by the seller within the last three years so far as known to the buyer;
(3) The location and general description of the property to be sold;
(4) The place, and the date on or after which the bulk sale is to be consummated; and
(5) Whether the bulk sale is subject to UCC section 6106.2 and if so, the information required by subdivision (f) of Section 6106.2 (the name and address of the person with whom claims may be filed and the last date the claims may be filed, which is the last business day before the date of the bulk sale).
In any case where a bulk sale notice subject to the requirements of Division 6 of the UCC provides for an escrow, the buyer must deposit the full purchase price of consideration (not necessarily cash) with the escrow holder. If there is no escrow, then the transferee must apply the consideration as required by law.
(e) UPSIDE-DOWN ESCROWS
If the seller disputes a filed creditor’s claim, the escrow holder will withhold 125% of the first $7,500 of the claim and notifies the creditor. The creditor has 25 days from the mailing of the notice to attach the funds, meaning get a judge to issue a writ of attachment. If not attached, escrow holder pays the funds to the seller, or to other creditors.
If, at closing, the amount of funds deposited is insufficient to pay in full all creditors’ claims, the escrow holder must delay the closing, give notice to the creditors of the shortage within a specified time limit, and distribute the cash consideration and any installment payments in strict compliance with the priorities of established laws. No fees or commission are paid prior to closing.
Here is the priority of the payout in an upside-down escrow:
1. U.S. Government.
2. Secured Liens.
3. Escrow, professional charges and Broker Fees.
4. Wage claims given priority under Section 1205.
5. All other tax claims.
6. All other unsecured creditors.
If the procedure under the above are not followed, the buyer is liable to the seller’s creditors holding a valid claim against the seller. Creditors must take action within one year of the date of the transfer, unless the transfer was concealed (no bulk sale or escrow). In that case, action must be brought within one year after the creditor discovered the concealment.
(f) SUCCESSOR’S LIABILITY
In a business sale, the buyer (escrow holder does it for the buyer) must holdback enough funds to cover any and all outstanding tax liabilities. The Successor’s Liability extends to taxes incurred with reference to the business operation by seller or any former owner.
The buyer is released from further obligation to withhold funds if he obtains a certificate from the Board of Equalization stating no taxes, interest or penalties are due from the seller or previous owner.
This liability is enforced by service of a notice of successor liability. The Successor may petition the BOE for reconsideration of the liability.
(g) SELLING WITH NO BULK SALE
Paramount Restaurant Brokers, Inc. strongly encourages buyers to use an escrow company to perform a bulk sale transaction as well as getting creditor and government clearances. It is an insurance policy for the buyer. In the event the buyer insists on not using an escrow and/or not doing a bulk sale, then the agent must in writing included in the purchase agreement warn the buyer of the risks and strongly encourage the buyer to seek legal council on this matter.
When the seller and buyer agree not to conduct a bulk sale, the process to close the deal is drastically different, yet much simpler, than a full blown escrow process. In the purchase agreement the agent must check the box indicating no bulk sale will take place. Under the deposit section of the purchase agreement, the agent should indicate no escrow holder is used.
The following must be spelled out in the purchase agreement:
(1) The initial deposit check is to be a cashier’s check payable to the seller. The broker holds the check in a secure location for the benefit of the seller. The Buyer proceeds through the due diligence process. When the process is complete, the agent obtains a removal of contingencies signed by the buyer and seller.
(2) The Buyer then prepares two more cashiers checks. The sum total of the checks will be the purchase price less the deposit already held by the broker plus prepaid rent, rent deposits, and sales tax for the equipment. One check is payable to Paramount Restaurant Brokers, Inc. for the amount of commission owed by the seller and the other check is payable to the seller for the balance remaining.
(3) If inventory is involved in the sale, then the agent should meet the seller and buyer at the business the night before closing to perform an inventory and exchange a bill of sale and the money. Any inventory below or above the target amount is handle directly between the seller and buyer.
If there is no inventory, then the agent should meet the seller and buyer at the business the day of closing to exchange the bill of sale and the checks.
(h) BILL OF SALE FOR NO-BULK SALES TRANSACTION
There is a bill of sale on the SR and SS website ready for the agent to complete. Don’t get fooled though. It says warranty bill of sale. Warranty relates to the seller warranting to buyer he/she owns the property, not warranting the condition of the property. Agents often get caught off guard with such language.
The furniture, fixtures and equipment list must be attached to the bill of sale and signed by the buyer and seller. The seller only signs the bill of sale.
Mel Jones is one of the premier restaurant brokers in the nation having published hundreds of articles on buying and selling a restaurant and bar business, selling thousands of restaurants in CA., WA and AZ and building one of the most copied business models in the brokerage industry. Mel started SellingRestaurants in 2004 with the one simple concept, give the buyers the information they need to make intelligent buying decisions without being pestered by a broker or hiding information, prepare the business for market by researching key details that make or break deals and educate the buyer on the buying process to create an intelligent buyer. Prior to SellingRestaurants, Mel was a Chief Financial Officer for Universal Music Group, the largest music company in the world. There he participated in more than $11.5 billion of merger and acquisition transactions. He also work for top companies such as Nestle Foods, USA. He hold a Bachelors in Business Administration Finance as well as attened Law School at Gonzaga University. Give Mel a call at 480.274.7000 or e-mail him at [email protected] if you have any questions.